Pet Valu Holdings Ltd

TSX:PET

Earnings Call Analysis

Company Eyes Strong Q4 with Growth Initiatives

The company forecasts robust revenue of $1.055 to $1.065 billion, with a 5.5% to 6.5% increase in same-store sales and plans to open 35 to 40 new stores. Full year gross margin is projected slightly below the usual 35% to 36% due to unfavorable exchange rates and transformation costs impacting Q4 by nearly 200 basis points. Adjusted EBITDA is anticipated to reach $230 to $233 million. Approximately $60 million is earmarked for net capital expenditures, half of which is for supply chain transformation, before reducing to about $30-$35 million in 2025. The company continues to explore shareholder value-enhancing strategies, including potential share buybacks.

Solid Q3 Performance Amid Industry Resilience

Pet Valu, the Canadian pet industry leader, reported a robust third quarter with an 8% system-wide sales growth. This uptick is credited to an increase in same-store sales and the successful opening of new store locations. The company emphasized its commitment to providing a comprehensive omnichannel experience, synergizing their physical and digital presence to meet consumer demand for a seamless shopping journey. Pet Valu's strategic business execution is evident in their adjusted EBITDA margins reaching an impressive 21.8%, a reflection of their ability to adapt to varying sales levels.

Strategic Expansion and New Store Openings

The expansion blueprint for Pet Valu is aggressive but methodical, with plans to enhance their already dominant market position by adding 500 stores in the upcoming years. Despite current challenges like delayed greenfield sites and anchor tenant postponements affecting store openings, 22 new stores were opened year-to-date, totaling 766 locations. The near-term projection has been adjusted to 35-40 new stores in 2023, but the company maintains its long-term target of 40-50 stores annually, bolstered by a robust franchisee interest pipeline.

Consumer Behavior and Same-Store Sales Growth

The company reported a same-store sales growth of over 4% against a backdrop of significant growth in the previous two years. This growth was fueled by increased average spending, with premium food lines and services experiencing strong trends. Notably, their culinary and premium dry food lines led the charge, alongside a store refresh program that included several renovation and expansion projects. The company also spotlighted their versatile offerings, with the performance in naturals line underscoring their capacity to cater to varying customer value needs.

Product Innovation and Marketing Strategy

The third quarter saw Pet Valu launch almost 200 new toy SKUs and expand their Bailey & Bella apparel line, demonstrating their dedication to product innovation. The marketing team supported these efforts through multiple channels and promotions, contributing to brand enhancement and increased traffic. Alongside this, the introduction of a fall fashion digital look book and local media engagements with ACEs and franchisees plays a crucial role in community-based marketing success.

Advancing Digital Strategy and Loyalty Programs

As part of its digital strategy, Pet Valu introduced user experience features to its digital platforms, such as loyalty program badges and purchase history views. These improvements are instrumental in growing their loyalty member base and increasing wallet share. The company's meticulous attention to customer engagement online is a strategic move to stay ahead in an increasingly digital retail landscape.

Margin Improvement and Supply Chain Optimization

Pet Valu's EBITDA margins were not only healthy in Q3 but are expected to benefit further from SG&A leverage in Q4. Distribution costs savings from winding down 3PL usage and a seasonal mix anticipated to provide modest benefits underline the company's proactive approach to cost management. With the opening of their largest distribution center in the Greater Toronto Area, Pet Valu is poised to refine its supply chain, expecting to unlock an additional $50 million of annualized wholesale purchases within the next 24 months.

Outlook and Financial Health

Looking forward, Pet Valu anticipates fostering SG&A leverage and foresees continued growth alongside industry trends of humanization and premiumization. Despite foreign exchange pressures and supply chain transformation costs, the business aims to sustain long-term margins between 35% to 36%. Factoring all elements, the company projects driving long-term profitable growth into 2024 and beyond.

Addressing Competitive Landscape and Promotional Trends

The company noted that promotional intensity across the pet industry returned to pre-pandemic levels, aligning with expectations. While facing margin pressures from vendor cost increases and currency exchange effects, Pet Valu has leveraged insights from commodity forecasting and proprietary brand products to manage these challenges effectively. Their strategy seemingly maintains a balance between competitive pricing and margin protection.

Capital Expenditure and Working Capital Management

Pet Valu anticipates CapEx levels in 2024 to mirror those of 2023 before reducing to a sustainable $30-35 million in 2025. The company acknowledges the need to manage working capital closely due to its supply chain transformation's ongoing requirements. This prudent financial management is pivotal for maintaining service levels while transitioning to new infrastructure.

Continuing Transformation and Integration Efforts

The leadership at Pet Valu has expressed confidence in their 46-year history of adapting to market cycles. Through successful integration of Chico, opening of new stores, and rolling out proprietary brands, the company continues its transformation journey. They are making strides in unlocking wholesale revenue potential and leveraging new distribution centers, with anticipation for automation developments in the coming years.

Earnings Call Transcript 2023-Q3

[Operator]

Good morning everyone! Thank you for standing by. Welcome to Pet Valu's Third Quarter 2023 Earnings Conference Call. My name is Chach, and I'll be coordinating today's call. [Operator Instructions] I'd now like to turn the call over to James Allison, Investor Relations at Pet Valu. Please go ahead, Mr. Allison

[James Allison, executive]

Good morning, and thank you for joining Pet Valu's call to discuss our third quarter 2023 results, which were released this morning and can be found on our website at investors.petvalu.com. With me on the call is Richard Maltsbarger, President and Chief Executive Officer; and Linda Drysdale, Chief Financial Officer. Before we begin, I would like to remind you that management may make forward-looking statements, which include guidance and underlying assumptions. Forward-looking statements are based on expectations that involve risks and uncertainties, which could cause actual results to differ materially from those expressed today. For a broader description of risks related to our business, please see our Q3 2023 MD&A, 2022 annual information form and other filings available on SEDAR+. I would also like to note that today's remarks will be accompanied by our earnings presentation for Q3 2023, which can be viewed through our live webcast and is also available on our website. Now I'd like to turn the call over to Richard.

[Richard Maltsbarger, executive]

Thank you, James, and good morning, everyone. I'll begin my comments today with highlights from the third quarter before sharing our outlook for the fourth quarter. The Canadian pet industry continues to demonstrate its resilience driven by sales of recurring need-based consumable products and services. Our customers have consistently indicated through their feedback and behaviors, that they desire a comprehensive, omnichannel experience, and we are delivering this through the integration of physical and digital channels as well as the personalized service and expertise offered by our ACEs. I am proud of how our teams and business performed in the third quarter. We delivered system-wide sales growth of 8%, supported by both same-store sales and the strength of our new store openings. We paired this growth with stronger-than-expected adjusted EBITDA margins of 21.8%, highlighting our team's ability to adjust to varying sales levels. At the same time, we advanced critical strategic initiatives designed to drive long-term profitable growth. Let me cover some highlights. In the quarter, we opened 8 stores, bringing us to 22 new stores year-to-date. We ended the quarter with 766 stores coast-to-coast. We are now over 3x larger than our nearest competitor in the small format neighborhood market, and we have a strong position in the nearly $8 billion Canadian pet supplies industry. We plan to further strengthen this position by opening an additional 500 locations over the coming years. To help us accomplish this, we continue to have a robust pipeline of interest from prospective franchisees and existing owners looking to add stores. As we noted last quarter, we are seeing certain developers delay some greenfield sites. And more recently, there are some anchor tenants postponing opening date. We strongly prefer to open our stores at the same time or after the primary anchor, be it grocery, pharmacy or others. Given these shifts, we expect a handful of stores earmarked for opening in December, will now open in 2024. As a result, we expect to open between 35 and 40 stores in 2023. We continue to believe that 40 to 50 stores a year is the right pace over the longer term. On a same-store basis, sales grew just over 4% on top of 15% last year and 20% the year before. Growth was fueled primarily by higher baskets with both inflation and favorable mix contributing as we continue to see stronger growth in our more premium food tiers. We also continue to see benefits of our ongoing store refresh program, which included 11 renovation, expansion, or relocation projects in the quarter and 29 year-to-date. We continue to see new opportunities to relocate or expand working closely with landlords to have forward visibility in our highest priority locations. From a category perspective, we continue to see strong trends in consumables and services, which together grew high single digits on a same-store basis. Performance was once again led by our culinary and premium dry food lines. As a reminder, Pet Valu carries a broad suite of products for devoted pet lovers, including our deep selection of specialty pet exclusive and proprietary brand products. In our lower priced food tiers, where we have seen some price sensitivity, we have strong growth in our performance in naturals line, showcasing the versatility of our offering and our ability to serve our customers when looking for value. At the same time, the softness in several hardline products seen in late Q2, continued throughout the third quarter. We were pleased with consumer response to our tactical targeted promotions in July and August, which leads us to believe a continued rational approach to promotions in key periods is appropriate. Our merchants are continually refreshing our product offering to drive excitement for devoted pet lovers. In the third quarter, we introduced almost 200 SKUs of new toys under our proprietary brand, Jump, which are helping to drive proprietary brand expansion in that category. We expanded our Bailey & Bella apparel line with our fall and Halloween programs, and we launched an expanded line of collagen and bully stick alternatives, further providing safer and more digestible alternatives to Rawhide. Our marketing team remains focused on both enhancing our brand and driving traffic. These actions are highlighted by the support across multiple channels for our big performer trend sale in July and our Tuesday flash sales in August. In September, we released our fall fashion digital look book to enhance discovery of our exciting Bailey & Bella fall apparel line and drive traffic to our website. We then delivered industry-leading animal care expertise with local media engagements, highlighting our ACEs and franchisees. These local operators and franchisees are critical elements to our marketing success. Their unwavering support of local charity events, clinics, educational programs and local adoption weekends are instrumental in building our brand, community by community. As we advance our digital strategy, we continue to see growth in traffic and sales generated online as our digital teams recently added several features to enhance the user experience. This included badging to identify products eligible for our loyalty program, saved address and payments, recent online and in-store purchase history, Treat of the Month recommendations and strong growth in our first few months of online pet profiles. These actions are helping to grow our loyalty member base and further share wallet with our most active customers. And finally, on margins. Our third quarter adjusted EBITDA margins were 21.8%. Excluding supply chain transformation costs, we delivered gross margins consistent with year-to-date trends as strong execution by our merchandising and supply chain teams help manage our variable costs while funding tactical promotional activity. At the same time, we realized leverage in our SG&A rate when excluding non-recurring items as we effectively adjusted our investments at the store level to reflect the needs and demands from our customers, while we reprioritized certain corporate investments. Throughout the quarter, we continued investing in our ACEs with corporate stores operating with more hours and higher wages than in 2022, and we continue to provide incentives for our franchisees so they can choose to do the same. The third quarter also saw us achieve significant milestones in our multiyear supply chain transformation. We officially opened our new GTA DC, the largest in Canada serving pet specialty and a critical component of what we believe will be the country's strongest pet specialty supply chain for years to come. We successfully transferred all bulk picking activities to the new GTA DC, which now services all stores in Ontario and Atlantic Canada and is allowing us to exit one of our legacy warehouses and wind down expensive 3PL usage in the region before year-end. As with any transition, we had a few weeks where we had to adjust to new processes, but due to quick and tireless actions from our teams, we returned to normalized service levels by the end of October. Most importantly, as planned, we are now seeing the savings expected from exiting the outside 3PL services and are beginning to see the efficiencies of our bulk picking once again being in a single built-for-purpose and scalable distribution center. The final phase of activating our GTA DC is now underway as we have commenced construction of our automated goods to Picker system and expect to transition our piece-pick operations and wind down our last legacy building in the GTA during the first half of 2024. And I'm really pleased to announce that we have started unlocking the potential wholesale revenue to our Chico business. Just last week, we shipped our first ever pick and ready pallets from the GTA DC to stores in Quebec. At the same time, we also shipped our first national brand foods, Acana and Orijen from our own Pet Valu DC at the Chico's stores. These are critical steps to capturing substantial incremental wholesale revenues in our Chico banner. To give you a sense of the ultimate prize, today, we capture less than 10% of Chico's annual product purchases compared to over 90% for our non-Quebec stores. We see significant revenue and profit opportunity and expect to reach our interim goal to capture 50% of Chico's wholesale shipments by Q4 2025, with aspirations to increase that further in subsequent years.Achieving this goal will unlock at least $50 million of annualized wholesale purchases within the next 24 months. At the same time, we are progressing in the Vancouver market as we took possession of our new Vancouver DC just last week, a few months ahead of our original schedule. This new facility represents a significant increase in capacity with flexibility for future expansion. We expect to transition all picking activities in mid-2024 with later automation in early 2025. As you can tell, we've been hard at work advancing our supply chain transformation. By the end of this year, we'll have deployed more than half of our $110 million investment and completed our heaviest year in terms of transformation costs. As we turn our focus to the remaining phases of the transformation, we are growing increasingly excited for the strength of our new supply chain and our ability to better serve our franchisees and devoted pet lovers across Canada. It has been an amazing few months with so many different long-term industry reshaping initiatives all beginning to converge as part of our strategic plan. Really, it's been an action-packed few years. Next week, I will be celebrating my fifth anniversary with this great company. I could not be happier to be part of the work our ACEs, franchisees and leaders have done to further strengthen this dynamic and resilient growth business. Since I joined Pet Valu, we have taken several of the most important steps in our 46-year history. We have completely modernized our customer-facing technology stack, including the rollout of a full suite of digital capabilities and omnichannel fulfillment stretching coast-to-coast. We have grown our network by almost 200 stores with our now 766 stores, positioning us closer to more Canadians than any other pet specialty player. We have gained a market share leadership position in Canadian pet industry. And we are on pace in 2023 to double our revenues and achieve an eightfold growth in our adjusted net income since 2018. These achievements have required purposeful investments, concerted efforts in collaboration and an ability to adjust to changing conditions, including an acquisition, a pandemic and an IPO. Each element has required our teams to execute complex projects and they have delivered. We continue our journey of making targeted investments to drive long-term profitable growth, while we achieve our mission to be Canada's preferred pet retailer now and through the next decade. We believe we are building Canada's strongest pet specialty supply chain. When completed, this supply chain will support our growth for at least the next 10 years at industry-leading speed and efficiency. We are now unlocking significant wholesale revenue, proprietary brand and profit opportunity with our Chico banner. This opens up more than $50 million in annualized wholesale revenue within the next 24 months. We are enhancing our omnichannel capabilities to further improve user experience and operational flexibility, supporting online sales and traffic-driving activities to our nationwide store network. And we continue to build new stores on our mission to be the most convenient neighborhood pet option for Canadians, especially in the rural and outer suburban markets where our format and our franchisees give us a distinct advantage. These investments will deliver both capacity for our continued growth and support improved profitability as we exit this high investment period over the next few years. All the while, we will continue to operate our business responsibly and adapt where necessary. We will continue to take responsible actions to manage our costs while facilitating investments in growth. We will continue to bring forth a rational mindset to promotional activity even while we work to add discretionary items to our customers' baskets. History has shown pockets of suppressed demand for discretionary pet products are usually temporary with demand strengthening as macro pressures ease. We see no reason why this will be different this time around, and we are continuing to build the capabilities to win now and in the future. From rational promotions to responsible cost management to continuing to invest in the long-term capabilities for profitable leading growth in the Canadian pet industry, we reflected this thinking in our refining guidance for 2023, which Linda will discuss shortly. I am very proud of the work our leaders, ACEs and franchisees have done to be able to maintain our long-term growth orientation even while adjusting to current market conditions. Now over to you, Linda.

[Linda Drysdale, executive]

Thank you, Richard, and good morning, everyone. Overall, Q3 showcased the adaptability and financial discipline of our teams, which enabled the business to deliver healthy profits despite softer top line growth. Third quarter system-wide sales increased 8% to $357 million, supported by organic growth across channels and the addition of 37 net new stores over the last 4 quarters. We opened 8 new stores in the third quarter and 22 year-to-date. As of Q3, our store network consists of 766 locations, 71% of which are franchised, up from 68% last year as we purposefully grow our franchise mix over time. On a same-store basis, sales grew 4% with the average basket increasing by a similar amount, together with positive transaction growth. Turning to our company performance, third quarter revenue was $262 million, an increase of 7%, similar to the growth we saw in system-wide sales. Gross profit was $87 million, a decrease of 7% from Q3 last year. As a percentage of revenue, gross margin rate was 33.3%. Excluding 180 basis points of costs related to our supply chain transformation, gross margin rate was 35.1%, down 310 basis points from last year, but better than we had anticipated. The year-over-year decrease was primarily driven by lapping a $1.8 million duty recovery received last year associated with COVID relief measures, a weaker Canadian dollar, unfavorable product margins despite lower inbound freight costs and higher discounts related to planned promotional activity. A quick reminder that from a sensitivity perspective, every penny change to the U.S. Canadian exchange rate year-over-year roughly translates to a 10 to 15 basis point move in gross margin, typically on a 90-day lag basis, given inventory turns. Selling, general and administrative expenses in the third quarter were $50 million. Excluding costs not indicative of business performance, our SG&A expenses were approximately $46.4 million, flat to last year, but 120 basis points favorable as a percentage of revenue. This favorability was largely a result of near-term purposeful adjustments to adapt our business to the evolving consumer demand environment. I'm very proud of our team's ability to quickly pivot where possible while continuing to advance our long-term strategic initiatives. Adjusted EBITDA was $57 million or 21.8% of revenue, representing a sequential improvement from 21% in Q2 and ahead of expectations we provided back in August, driven by rigorous cost control and stronger-than-anticipated gross margins. Net income was $18 million compared to $27 million last year. Adjusted net income, which excludes items not indicative of our underlying performance was $28 million, down 8% from last year, driven entirely by higher interest expense, given rising rates and higher depreciation. Adjusted net income per diluted share was $0.39 compared to $0.43 last year. Now turning to the balance sheet, we ended the quarter with $11 million of cash on hand, while our $130 million of revolver remained undrawn. Total debt net of deferred financing costs at the end of Q3 was $297 million. Considering lease obligations, our leverage ratio remained at 2.2x. The increase in leverage compared to Q3 last year primarily reflects the recognition of the lease obligations associated with our new GTA DC, which added 40 basis points in leverage. In Q4, we will also recognize the lease obligations for our new Vancouver DC, which will impact leverage by approximately 30 basis points, all else is equal. Our inventory balance at the end of Q3 was approximately $135 million, roughly flat to Q3 last year despite growing our sales and revenue. I want to commend our procurement, replenishment and supply chain teams for all their hard work to adapt to evolving business needs while simultaneously navigating the complexities of our DC transition in the GTA market. Our teams have adapted quickly such that we are comfortable with the quantity and quality of our inventory, both in our warehouses and in our corporate and franchise stores. Net capital expenditures were $13 million in the third quarter and $41 million year-to-date, largely related to the construction of our new GTA DC and related warehouse systems and growth CapEx for new stores and rentals. Free cash flow in the quarter was $18 million, roughly similar to $20 million last year. I want to briefly share a recent development in relation to the CRA's examination of our tax filings. In September, the CRA reassessed us an additional approximately $6 million in income tax plus interest related to our 2018 taxation year, on the basis that certain interest expenses incurred that year were not deductible. We plan to contest the reassessment. We and our tax advisers believe our tax filing positions are appropriate, and accordingly, no provision has been recorded in our consolidated financial statements in respect of the 2018 reassessment. Now turning to our outlook, the structural tailwinds underpinning growth in the Canadian pet industry remain fully intact. Like many parts of retail, our industry has been impacted by lower demand in discretionary items. And based on current and projected conditions, we do not anticipate this backdrop to improve materially in Q4. Based on this and our year-to-date performance, we have narrowed our 2023 outlook provided earlier in the year. We expect full year revenue of between $1.055 billion and $1.065 billion, supported by same-store sales growth of between 5.5% and 6.5% and 35 to 40 new store openings. As Richard mentioned, delays on certain greenfield developments are expected to push back opening date for a handful of stores from December into early 2024. Our guidance implies robust revenue growth of between 7.5% and 11% in the fourth quarter. Consistent with prior expectations, we continue to expect full year gross profit margin to land slightly below our historical range of 35% to 36% after factoring in unfavorable foreign exchange rates and approximately 100 basis points of costs associated with our supply chain transformation. Specific to the fourth quarter, we expect supply chain transformation costs to impact reported gross margin by approximately 200 basis points. On adjusted EBITDA, we expect to reach between $230 million and $233 million. This implies an acceleration in Q4 adjusted EBITDA margin. Let me walk you through the elements underpinning this expectation. First, we plan to continue the responsible expense control actions taken in Q3 through the balance of the year, which should deliver meaningful SG&A leverage compared to Q4 last year. Second, we expect to realize some savings in distribution costs with the recent wind down of our third-party storage facilities in the GTA. And third, we anticipate a modest pickup in mix due to seasonality. Factoring in our refined range for adjusted EBITDA, together with elevated but stable interest expense and an effective tax rate of approximately 26.5%, we expect adjusted net income per diluted share of between $1.60 and $1.63. For costs excluded from the calculation of adjusted EBITDA and adjusted net income, we continue to expect to incur $17 million in business transformation and $4 million in IT transformation and $7 million in share-based compensation. And finally, for net capital expenditures, we continue to expect to spend approximately $60 million, roughly half of which is related to our supply chain transformation. On the topic of capital, we continue to adhere to our capital allocation framework, which prioritizes the highest return investments for our shareholders. This begins with reinvesting to drive growth through organic and inorganic means, optimizing our capital structure and flexibility and returning excess capital to our shareholders. Given the current valuation of our shares, we are taking a closer look at normal course share buybacks as a potential use of excess capital generated in the near to medium term. We've also begun to map out our plans and initiatives for 2024 and look forward to providing our financial and operational outlook for next year when we report our Q4 results in early March. That said, as Richard mentioned, we maintain conviction in our ability to deliver long-term profitable growth. As we have shared in the past, we plan our business to grow with the industry, which has historically been mid-single digits per year and then strategically lean into opportunities to gain market share when possible. We continue to believe our business can support normalized gross margin levels of between 35% and 36% over the long term and aspire to realize slight SG&A leverage to deliver operating margin enhancements. Putting our framework into context with the current environment, as Richard mentioned, we are planning our business to assume softness in discretionary products to continue over the near term but expect this to improve alongside the macro backdrop. With that, I'll turn the call back to Richard.

[Richard Maltsbarger, executive]

Thank you, Linda. As Linda noted, Pet Valu has adapted many different economic consumer demand and pet industry cycles. We are excited about the future trajectory of our business. Beyond sustainable tailwinds of our industry, we are positioning to capture outsized revenue and profit growth as we realize the benefits of a more efficient supply chain, together with beginning to realize the wholesale revenue potential of Chico. I am proud of the efforts our ACEs, franchisees and leaders continue to bring to their roles every day. Together, we make the long-term investments and build the operating models to sustainably contribute to the Canadian economy for many years to come. More specifically, we work to build strong franchisee relationships, create quality working environments for ACEs to thrive and grow, offer the highest quality products and services to help care for pets and responsibly steward our role as a leading Canadian company through appropriate corporate governance and resource management. These actions, alongside our Four Paws service model and our core beliefs, position Pet Valu to be the pet specialty retailer for devoted pet lovers looking for the best solutions in the market to help create the healthiest, most playful lives possible for their pets. And it's for the lives of those pets that we do what we do. With that, we are now happy to take your questions.

[Operator]

Thank you, Richard. [Operator Instructions] Our first question today comes from Mark Petrie from CIBC.

[Mark Petrie, analyst]

I wanted to ask first about the same-store sales growth deceleration that you're seeing, and I know it's hard on a short-term basis, but when you look at the components, do you think it's consumers just spending more cautiously within your store or consumers stepping up the shift to lower-priced channels and retailers?

[Richard Maltsbarger, executive]

Mark, this is Richard. I'll go ahead and take the question for you. So look, at the highest level, we continue to see really sustained demand in our consumables business. Foods, treats, litters, again, over 75% of our sales, for the most part, what we see is devoted pet lovers continue to seek out those really premium pet foods. So natural enhanced dry kibble like Acana or Performatrin Ultra, culinary, like frozen raw including Big Country Raw, we're still seeing our highest growth in those categories. At our lower tiers of food, which would effectively be equivalent to the premium products found in food, drug and mass and account for about 10% of our food sales, we are seeing some increased interest in our proprietary brand foods, most especially Performatrin Naturals. The good side is, this suggests there may be some higher price sensitivity, but we are pleased to be able to provide them with a high-quality lead first alternative inside of our proprietary brand lineup, add a value to the customer. Strongly reinforcing the strength of having our diverse offering and the ability to meet any evolving needs as we go through a demand cycle. Really, Mark, it's on the hardline side, the softened demand trends we first saw in late Q2 continued through the quarter as we'd expected. We've heard very similar conversations out of others within the overall retail sector around discretionary demand. For us, this is manifesting mainly in categories like collars, leashes, crates, beds and toys, really where the devoted pet lovers have a comfort our flexibility on the cadence of how often they refresh the products. As I mentioned in my prepared remarks, we were pleased with our consumer response to tactical targeted promotions in August, which really focused on many of these categories. It's actually one of our slower months of the year. So we really like what we saw coming out of it. However, we did see greater than we expected a softening late in the quarter, most specifically on hard lines when not on promotion. So this does lead us to believe that a continued rational approach to [indiscernible] key periods is going to be appropriate, allowing us to balance traffic and adding to the basket. The last thing I would say is, look, our momentum in Q4 to date has been pretty similar, but it's important to note that we still have some very big weeks ahead of us with Black Friday, Cyber Monday and the lead up to the holidays. So overall, I do believe it is a general industry condition as we've heard it come from other retail sectors as well as ours. Our sales trajectory according to our third-party market share vendor is quite correlated directly with what they're seeing in the shape of overall market demand. And so we feel pretty confident that this is a temporary softening primarily in the hard lines categories, and we're going to continue to invest through the cycle.

[Mark Petrie, analyst]

Okay. And if I could just follow up with regards to the sort of sales trajectory. You lowered the same-store sales guidance for the year as well as the store count. I'll leave that question for somebody else, but you tightened the range on revenue guidance. So I know there are a few different buckets in revenues, but can you just help bridge the sort of lower same-store sales growth but a tighter range for revenue?

[Linda Drysdale, executive]

Yes. Hi Mark, it's Linda speaking, and I'll take that question. So as you know, we have several revenue streams, including our corporate store sales, shipments to our franchisees and other franchising revenues. And while industry conditions have lowered our same-store sales growth expectations, we expect this to be partially offset by stronger wholesale shipments for 2 reasons. First, we benefited from higher fill rates to our franchisees in the first half of the year as our in-stock levels at our [indiscernible] improved alongside global supply conditions. And second, we're also now starting to increase our wholesale shipments into Chico with the transition into our new GTA DC. So the adjustments to our new store openings, we'll take that one as well since you mentioned it. As we mentioned in our prepared remarks, is related to the plays in new stores earmarked for opening late in Q4, which have a negligible impact on 2023 revenue.

[Mark Petrie, analyst]

Yes. Okay. And maybe just on that store range since you touched on it, I'll just ask, I mean you said 40 to 50 is -- you believe is still the right pace for the longer term, but based on what you see today, is that still realistic for 2024?

[Richard Maltsbarger, executive]

Mark, we do feel it's still realistic for next year. So while we'll have some stores slip from this year to next year, we may have a few slip from next year into ‘25 within our pipeline, but overall, the pipeline is still set up pretty strongly for a 40% to 50% target range. We'll ultimately provide the actual range as part of guidance in March, but we're still working through and feel we have good strength in the pipeline with a good mix of existing space as well as new developments.

[Mark Petrie, analyst]

Yes. Okay. Perfect. Appreciate all the comments and all the best for your holiday.

[Operator]

The next question is from Irene Nattel from RBC.

[Irene Nattel, analyst]

Thanks, and good morning, everyone. Thanks for the detail on the consumer demand side. That's really helpful. You alluded to consumer sensitivity to promotions, but can you talk about what you're seeing with respect to competitive activity in general and also particularly in the GTA posted the arrival of Chile?

[Richard Maltsbarger, executive]

Sure thing Irene, this is Richard. I'll take that. Pretty much has been the trend throughout 2023. We continue to see promotional intensity across the industry in the third quarter normalized back to pre-pandemic levels in line with what we expected. We're still working our way back to the level of promotions that we were doing in 2019 before the pandemic. This includes specific tactical actions we took to drive traffic to our stores, build the basket, build excitement around more discretionary oriented product lines. As for our peers, we continue to see rational behavior as has been the case for many years. Look, we monitor all competitors, including the one you just mentioned. And I'll just reiterate my prior statements, we continue to see behavior in line with what we expected.

[Irene Nattel, analyst]

That's very helpful. And then just coming back to the idea of the product margins, which you noted, there's some pressure on margins independent of the FX. Can you talk about what's going on there? Is it just simply the higher promotional activity? Or is there something else going on?

[Linda Drysdale, executive]

In terms of margins, I mentioned on the call, Irene, a number of factors. And first of all, lapping the duty recovery from last year. So that was one of the pressures as well as FX, as you mentioned. And then the product margins with the increased vendor cost that we are not passing through all at once and then a little bit on the discounting. In terms of what we see going forward, we do see in terms of EBITDA margin, we expect to realize meaningful SG&A leverage in Q4, both sequentially and year-over-year, resulting from the expense control that we initiated really leaned in on in Q3 during and also in Q4 having a higher volume quarter. And second, we are starting to realize savings in distribution costs from the wind down of the 3PL usage in the GTA. And third, we'll anticipate a modest benefit from the seasonal mix. So those are the main drivers for Q3 and then leaning into Q4 as well.

[Richard Maltsbarger, executive]

And Irene, I'll just layer on similar to what -- just taking it back on gross profit, just similar to what she said. What we have seen most particularly in vendor cost inflation, is that while overall consumer inflation seems to be slow a bit, food inflation is still outpacing that with many of our ingredients coming from the same supply chain. We do have our product vendors still trying to push through incremental cost increases above what you're seeing in retail prices. The great news is our team working through commodity forecasting and the insights we get out of our own proprietary brand product, understand which of those may be reasonable. We are pushing back appropriately, but do still continue to see product cost inflation to date, outpacing overall inflation in the market.

[Irene Nattel, analyst]

That's super helpful. And that's exactly what I was referring to. So looking forward, presumably, as some of those are [indiscernible] commodity costs and sort of the food inflation moderates, some of that pressure should work its way through the system?

[Richard Maltsbarger, executive]

We are expecting that's why, as Linda noted, again, our overall long-term planning approach for margins is in that 35% to 36% range. Really, right now, we are at an intensity level of product cost inflation layered on with the FX on the 30% that we import, that's greater than normal to what we see in the market. We do believe that if we continue to see the patterns we're seeing in consumer demand and GDP within Canada, that cost inflation will also begin to slow.

[Operator]

The next question on the line is from Martin Landry from Stifel.

[Martin Landry, analyst]

Good morning. I was wondering if we can touch a little bit on your margins and the benefit from your supply chain improvement. I understand now that all your supply chain transformation costs are excluded from your reported results. So looking at next year, given that all of that is excluded, is there a benefit on the EBITDA margin from your new distribution center in the GTA? Just trying to understand a little bit, given that you back out a lot of costs now, what that new DC tailwind to your margins next year?

[Linda Drysdale, executive]

Hi Martin, it's Linda. I'll take that question. So there's a few ways to take that. I'll start with talking about 2024. And so as I indicated in my prepared remarks, we are currently putting together our plans for 2024, and we'll announce our financial outlook for the upcoming year when we report our Q4 results in March. That said, I can provide a few broad comments to help with the building blocks, and I'll step through each of the elements. So on sales and revenue, we plan our business each year to grow with the industry and then lean into the opportunity to take share when available. Given the current backdrop, it's difficult to call how positive industry growth will be next year, but the underlying tailwinds of humanization and premiumization remains fully intact. And we expect we will be able to fully participate in that growth. On gross margins, we continue to believe our business can support margins of between 35% and 36% over the long term. We also expect slight FX pressure in early 2024 based on where the current exchange rates and forecasts are today. And then specific to supply chain, we expect margins to be a bit below the low end of our long-term range, given we are incurring duplicate car across the next 2 years. So not just this year, Martin, but also into next year. And then moving into modern buildings with larger lease obligations, so we will see a step-up in depreciation, as you saw in Q3. And then I'll just close it off on SG&A, we plan to achieve leverage over the long term as we grow revenue faster than expenses, and we're currently closely managing our expenses and expect to continue that into the next year. So putting all these building blocks together, we believe we will be able to continue to drive long-term possible growth in 2024 and beyond.

[Richard Maltsbarger, executive]

And Martin, again, we continue to be excited about the growth potential. One of the things that Linda noted, she's given you the numbers, but just to reiterate, we were well over 100% capacity on our supply chain going into 2022 even, not even just 2023. And with the opening of the GTA facility, we have now transitioned our entire bulk picking operations in the Greater Toronto area, actually supporting all of Ontario and Atlantic Canada into the new GTA DC as well as we've been able to exit one of our legacy GTA buildings and by the end of the year, we'll be out of all of the 3PL support. So primarily, we'll get some near-term cost savings. But Martin, it's still going to be a little bit bumpy in terms of being able to explain all the direct benefit as next year, we'll continue to have a high year of duplicate cost, as we took possession of our Vancouver DC just last Thursday, and we'll be bringing that online until sometime in the middle of 2024 as we transition in.

[Martin Landry, analyst]

Okay. But look, if we keep things simple and look at this on an adjusted EBITDA basis, I believe that those duplicate costs are backed out of your adjusted EBITDA numbers. So I mean, are you going to continue to back out those duplicate costs for your Vancouver DC next year? Or now they're going to be -- if we look at this on an adjusted basis, I mean all that supply chain transformation is all backed out, right? So that's what I'm trying to figure out what's the tailwind next year from your new GTA distribution center?

[Richard Maltsbarger, executive]

Yes. So the tailwind will be twofold. One, there will be some operating expense efficiencies. That's why we have confidence that despite growing our direct-to-e-commerce, sorry, our direct-to-home e-commerce business and despite more of our business becoming wholesale versus retail, we can maintain that 35% to 36% margin rate. The other real benefit will be in revenue. As I noted on the call, the GTA DC was the key to unlocking our wholesale revenue potential at Chico. So as you think about the new benefits coming out of the GTA DC, also look a little bit further up the income statement. As we noted on the call, we're unlocking upwards of $50 million of revenue potential across the next 2 years as we just started shipping our first national brand product ever, directly out of our GTA DC to Chico last week with a Canine Orijen running alongside our own proprietary brand products.

[Operator]

The next question is from Michael Van Aelst from TD.

[Michael Van Aelst, analyst]

I just wanted to go back to the same-store sales. And heading into the corner, I know you wanted to try and promote a little bit more aggressively to sustain your same-store sales in that 6% to 7% range. You say you are a little -- you're happy with the promotional effectiveness, but your same-store sales fell short. So where do you see the shortfall? And when you exited August and went into September and you didn't have those promotions, did you see some of those sales fall off to the point where you're -- it might suggest you're just pulling sales forward into August from September?

[Richard Maltsbarger, executive]

Mike, thanks for the question. Just as I said in my prepared remarks, we like what we saw in terms of consumer response to the tactical promotion. It really was when we were off a promotion. We didn't promote in September. We really haven't promoted in the first part of October. Thus, we did see lower than we were expecting in those months. That really is the key difference between where we were exiting Q2 and where we come out exiting Q3. That softness in hard lines. And really, again, you heard across many other retailers, general softness in discretionary products is at a greater rate than we are expecting.

[Michael Van Aelst, analyst]

Okay. So there is -- you didn't see any indication of just pulling forward sales into August. There was more just that they went back to the levels that you would have been, say, in July when you pulled off the promotions?

[Richard Maltsbarger, executive]

Yes. And actually, just a bit even below, Michael. So that is the one exception, as I noted in the call, it's just when off promotion, the discretionary products continue to have slowed. But again, no more so than other sectors of retail. And with our key products being the 75% of our business that is consumables, including food and litter and treats that are up over high single digits to certain categories still being in low double digits, especially around our most premium tiers. We like what we're seeing in terms of our ability to continue to attract the devoted pet lover. We just do recognize that they are trading off or postponing some of the more discretionary products like leashes, collars, toys and treats.

[Michael Van Aelst, analyst]

Okay. And then when you -- what is the recent consumer behavior lead you to believe about the consumers' health going into 2024 and how that might look for pet spend?

[Richard Maltsbarger, executive]

So overall, Mike, we are -- as Linda noted in her response just a few minutes ago to Martin's questions about 2024, we do continue to plan the business with industry expectation, which is generally in the mid-single digit across the last 30-plus years even through each of the last few recessions when they did occur within Canada, there was still positive growth. So we are still planning for positive growth. We'll have our guidance in March once we do that. We're literally in the midst of planning right now. We, just like you are reading all the different economists' forecast to understand where we believe the Canadian economy will be and where the Canadian consumer will be. While pet is definitely a resilient industry, it is not entirely recession-proof. And so we are adjusting our SG&A and our investment portfolio to be able to be in a position to flex both up and down as we continue to fall along with the overall Canadian economy shifts that we're seeing today.

[Michael Van Aelst, analyst]

Okay. And you did -- you were pretty successful in adjusting your operating expenses in Q3 to the level of revenues, and it sounds like you'll do the same in Q4. But how much more room is there to hold those, say, flat if you see your revenue growth moderate next year?

[Richard Maltsbarger, executive]

Yes. So we're quite confident in our ability to get to adjust. There are certain things that are outside of control. There was a 9% overall aggregate increase in minimum wage last year across Canada. That is a direct impact to our business, most especially in our corporate stores, but also to our franchisees for whom, of course, we look to try to be able to provide the right incentives and support as we go through different demand cycles. So I'm quite confident we can continue to adjust where we need to. And if we do see for some reason that those adjustments can't keep pace, we will provide that in our guidance in March. But we're quite confident going into the year. We have a good understanding at different revenues, at different market cycles, just exactly how we can flex. Again, the key for us is ensuring that we invest in the right level of activity within our stores to make sure that we provide the best customer experience. And that's where we're going to make sure we make the investments. Other things like back office and other productivity improvements will fall as they did now, a secondary position to ensuring that we take care of customers and protect our points of differentiation.

[Michael Van Aelst, analyst]

Okay. And just to clarify something you said earlier, Richard, on the promotional activity. It sounds like you will step up promotional activity in November and December. But do you see a need to focus some of that spending and activity on consumables at this point? Or is it strictly going to be focused on your discretionary items?

[Richard Maltsbarger, executive]

So Michael, it's a great question. For competitive reasons, I would prefer not to say exactly what we're going to promote across the next couple of months. Unfortunately, you are not the only person listening into the call. So I would say that we're going back to more normalized promotional performance similar to what you had seen in a pre-pandemic environment, so not really any heavier than what we saw in this industry that this has been for the past couple of decades. Where we will promote will be something I prefer to keep quiet. But I will note that currently, we are promoting our Performatrin family of products. As I noted on the call, we're seeing really good success now. If customers are looking for a little bit more price value, they are turning to and finding places like our Performatrin naturals line, which, again, competes very well with the super-premium levels that the grocery or mass try to position and that provides a better recipe panel for less cost.

[Operator]

The next question on the line is from Vishal Shreedhar from National Bank.

[Vishal Shreedhar, analyst]

Just wondering, for a business like Pet Valu, what kind of traffic should a business like this generate? What kind of traffic would you be satisfied with for the business like that?

[Richard Maltsbarger, executive]

Vishal, could you just clarify the question for me?

[Vishal Shreedhar, analyst]

Yes, sure. So the traffic growth that you provided has slowed sequentially. And I'm just wondering, on a longer-term basis, if there's a level of traffic that you'd be satisfied with? And is it reasonable to expect over the next couple of quarters for traffic to continue to moderate?

[Richard Maltsbarger, executive]

Thanks for the clarification, Vishal. Longer-term trends, if we go back prior to the pandemic, we would generally see about 40% to 50% of our overall same-store sales growth coming out of traffic growth over time. If you remember, we're comping up against some major dramatic traffic growth [indiscernible] of the last 2 years. Again, we had a 4% same-store sales growth on top of a 15% last year, on top of a 20% the year before that. And so really, what we're seeing is a bit of a normalization in patterns. Also, earlier in the year, we noted very clearly that we are seeing bag size trade up. So we let you know that most specifically in Q1 and then again in Q2, that one odd consumer behavior we're seeing is people aren't necessarily trading off the premium food that they want to continue to feed to their pets, but we are seeing some small size bag, people trade up to medium, some medium-sized bags trade up to large; as people trade up their bag sizes, that will reduce the number of times they need to return back to the store for normalized refill traffic. So what we're doing is that we're making sure that we adjust how we market and how we sell to the customers when they do come through the door, to ensure that as best as we can, we're continuing to add another item into the basket. And through the promotions that we ran in August and some expectations for what we'll be promoting in Q4, we'll continue to take actions to ensure that we capitalize on the traffic we are seeing.

[Vishal Shreedhar, analyst]

Okay. Just on the discretionary performance, what you said was the difference maker in your guidance expectations. Do you have -- could you help us with -- given that it's a small but important part of your business or not the majority part of your business, can you help us with the sales trends of that particular discretionary segment in the quarter?

[Richard Maltsbarger, executive]

Yes. So as I noted to Mike's earlier question, generally, we're continuing to see that softening in those particular categories as we saw in late Q2, continue through Q3 and into the beginning of Q4. And I say end of the beginning of Q4 because, again, we're about to enter the period in late November and December, that's usually the strongest period of the year for those particular categories. If I take you back to [Break], generally, we would see a pickup in those categories as part of the holiday season because, again, many of the different gift-giving opportunities for your pet are associated. One of the reasons why, for example, we had the Bailey & Bella digital look book was specifically to help people see the fall and winter selection. So as the temperatures turn colder, people begin to purchase more hard lines, more of a necessity in a replacement cycle and people purchase them as gifts. So we're quite excited about what we're bringing to market for this particular holiday season. As I noted on the call, we introduced almost 200 new jump toys, proprietary branded, generally at a 10% to 20% discount to the national brand toys that we were carrying on the shelf. So while there may be a slight same-store sales retraction from selling a 10% to 20% discounted toy, it also comes to us at a greater margin rate and dollar support. And quite frankly, we're able to increase the quality that we provide to our customers through our proprietary brands. So overall, Vishal, we are adjusting our expectations. That's why we provided the tightened range that we did for the fourth quarter effectively to recognize where we're seeing discretionary demand, and that's been taken into account as we've adjusted both our spending as well as our marketing approach for the quarter.

[Vishal Shreedhar, analyst]

Okay. Are you able to provide us with the number, like the decline year-over-year in Q3 associated with the discretionary categories?

[Richard Maltsbarger, executive]

We provided the guidance that we were at high single digits for our consumables, primarily in our food and our services, which again is around 75-plus percent of our business.

[Vishal Shreedhar, analyst]

Got it. And just lastly here, more of like a high-level thoughts, 2023, on the EPS line was a little bit of a reset, some of the good sales that you saw earlier in the year kind of been offset by D&A, depreciation, FX and other factors. So as I look -- and Q4, obviously, some of those factors, they start annualized on a year-over-year basis, and you're expecting good EPS growth in Q4. Wondering, as we look forward, are there other extraneous factors that you can consider that we should reflect upon as we build our models that might constrain kind of the EPS growth, so you don't get that leverage all the way down the P&L from your sales?

[Richard Maltsbarger, executive]

I don't believe so. I mean -- sorry, we're just trying to absorb the question here. I don't believe there's any factors that we haven't listed. Linda noted on the call, even down below EBITDA, right, of course, interest expense, and we continue to work through that heightened environment. But no, I think we've provided most of that in our prepared remarks -- maybe 1 or 2 more.

[Operator]

The next question is from Michael Glen from Raymond James

[Michael Glen, analyst]

Maybe just on 2024 again. I know you're still working through this, but can you give some indications about how we should think about CapEx in ‘24 versus the $60 million this year?

[Linda Drysdale, executive]

Yes, I'll take that, Michael. So as you noted, we're still working through our plans, but we can expect the level to be relatively similar to what we are planning to hit this year before falling to a sustainable level of roughly $30 million, $35 million in 2025.

[Michael Glen, analyst]

Okay. And then just on working capital, can you -- is there any opportunity as I think about your working capital where it is right now, like what is the opportunity to tighten up working capital as, say, a percentage of sales or lower inventory, anything along those lines in coming quarters?

[Richard Maltsbarger, executive]

We don't see a lot of opportunity in the incoming quarters. As we continue through the supply chain transformation, there will be a bit of pressure as we do have to carry some duplicate inventory as we're moving from one building to another to ensure service levels to our customers. So until we work through those, our primary goal will be to try to maintain our inventories roughly in pace with our overall revenue growth. We believe we'll be quite successful with that this year. You'll note we had flat inventories year-over-year this quarter as we managed to that target. We'll continue to manage to those targets, taking into account some slight overall. So I don't think you'll see much difference, Michael, between what you're seeing now going forward until we can transition through the full supply chain transformation. All right. Time for one more, please.

[Operator]

The last question we have time for today is from Michael Vu from Barclays.

[Michael Vu, analyst]

As the operator mentioned, this is Michael Vu on for Adrienne Yih. And I know that we are running up on time here. So I had a quick question related to the DCs. So you recently opened a new GTA DC. And if I'm recalling correctly, I believe in the past, you mentioned that your DCs and 3PLs were at like a roughly 150% capacity, and you expect a more normalized [indiscernible] to be at 60% with [indiscernible]. So with that said, would you please share some additional color on your progress towards achieving that 60% target? Or has that target changed overall?

[Richard Maltsbarger, executive]

No, the target has not changed overall. That really is more of a target I'd say probably post transformation. Our Calgary and Vancouver DCs continue to operate over capacity, including 3PL support in both Calgary and Vancouver. We are making great progress, primarily in bulk picking. Like I said, by the end of the year, we will be down in the GTA to only our new GTA DC and then our one remaining piece-pick operation. We have started the construction under permit with the city of Brampton, to build our new auto store automation within our GTA DC. So literally, construction is underway with a planned transition in early 2024. After that point, we will be in a great position to grow as quickly as we would like to grow across all of Eastern Canada, including, as I already noted, the ability to take on incremental wholesale to our Chico franchisees in Quebec. We will then transition Vancouver in mid-2024, including all bulk and piece picking with later automation coming in early '25 for Vancouver. And then we will be working next year to finalize our plan for Calgary, when and where and how that will transition. So overall, quite on track, quite pleased with what we saw, despite transitioning 3 buildings to our GTA DC, we had less than a few weeks of any sort of adaptation to new processes, and we are back up to our overall annualized service levels out of the greater Toronto area by the end of the year. So with that, thank you for the question. I do need to wrap up the call. So I would like to thank everybody again for investing their time into our company and your interest and the quality of the questions and discussion. We are quite excited; we have been working for a long time to pull all these different elements together. From the day we acquired Chico, we knew that the ability to tap in the wholesale revenue was going to be a critical part of the success of that overall acquisition. We have integrated the leadership team. We have opened new stores. We've introduced proprietary brands, and now we are shipping wholesale, including Acano and Orijen, 2 of their most popular brands. We are already beginning to see leverage out of the new GTA DC. It is a thing of beauty, and we hope to invite everybody there sometime in mid to late 2024, once we have the automation up and going. Quite excited to have moved into the Vancouver D.C. last week and get that process moving, as it was our second most constrained operation within our supply chain, and quite proud of all the work that the teams have done to be able to adapt our operating cost to the environment that we're seeing now. We've got a great 46-year history of being able to adapt into and out of cycles. And we're quite confident we'll be able to continue to do so. So with that, thank you all so much, and we look forward to talking to you again soon.

[Operator]

Thank you, everyone, for joining Pet Valu's Third Quarter 2023 Earnings Conference Call. You may now disconnect your lines, and enjoy the rest of your day.